Summer MBS Session More Hazy and Crazy than Lazy

This week appeared to be a likely preview of what the market will have to deal with this summer: a weak economy, European debt issues, and national debt/budget fighting between the Republicans and Democrats. All of this was in this was in the holiday-shortened start-to-summer week.

Weaker than expected economic news (Chicago PMI, S&P/Case-Shiller HPI, ADP Employment, ISM Index, and Consumer Confidence) and continued worries about Europe, particularly Greece, sent the 10-year note yield through the key 3% threshold by Wednesday to close at 2.966%, down 10 basis points from the previous Friday's close and to its lowest level since mid-December 2010.

Thursday dawned with Treasuries slightly lower on profit taking ahead of Friday's employment report; however, selling ramped up sharply on news of progress with Greece's debt issue and especially on a warning from Moody's of a potential downgrade in the U.S. credit rating if progress is not made on the national debt limit by mid-July. 10-year notes dropped 17+/32s with the yield backing up to 3.03% and the curve steepening nearly five basis points to +256.7. Prices firmed back up on Friday following much weaker than expected jobs creation along with an increase in the unemployment rate with the yield slipping back to 3.0% as of mid-day.

The mortgage market week began relatively uneventfully in terms of volume with some light index buying to close out May more than offset by money manager selling; however, volume picked up sharply on Wednesday on the strong rally with buyers emerging to outnumber sellers by a reported margin of 3:1.

Buying was focused in current coupons (4s and 4.5s) from real money, money managers and overseas. In addition, there was some limited convexity-related buying from servicers. Some profit taking emerged later in the day from real and fast money, while over the day banks and insurance companies were said to be better sellers. Higher coupons also saw interest as data (MBA's Refi Index and S&P/ Case-Shiller) pointed to continued muted prepayment speeds.

On Thursday's sell-off, lower coupons were pressured on fast money and mortgage banker selling; however, there was widespread investor participation buying up in coupon. On the rally on Friday following NFP, fast money and money managers were actively buying, primarily in 4s, while supply was uneventful. At mid-day, higher coupons were leading on the stack by 1+ to 2 ticks, while the lower end of the stack slightly wider.

Mortgage banker selling averaged $1.7 billion per day compared to $1.5 billion in the prior week. Meanwhile, Treasury slowly ramped up a new month with $2.0 billion in BWICs that consisted primarily of 4.5% and higher paper, especially HLB (High Loan Balance). Loan Balance paper is traditionally noted for its call-protection, and there has been increased interest reported from a variety of accounts for this kind of paper lately.

For the month of May, Treasury sales totaled $10.5 billion in FNMA and FHLMC MBS which brought the cumulative total of sales from their portfolio to $24.6 billion. They reported that as of the end of May, the principal outstanding in their MBS portfolio was approximately $106 billion, and at this time they appear to be on track to complete the wind down of their portfolio during the first quarter of 2012.

Tradeweb volume averaged 128% through Thursday, up modestly from 123% in the previous week. Over the week through Thursday, the 30yCC yield declined one basis point to 3.91% with the spread widening 2 basis points to +88 versus 10yr notes and unchanged at +76 versus 10yr swaps. Excess return on Barclays Capital's MBS Index MTD in June totaled +13 basis points and the sector led ABS (+0bps), CMBS (-61bps) and Corporates (-15bps).

For the month of May, the CC yield declined 18 basis points with the spread to 10yr notes and swaps widening respectively seven and five basis points. Excess return versus Treasuries in May on Barclays Capital's MBS Index was -19 basis points compared to -9bps for ABS, -85bps for CMBS and -27bps for Corporates.

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